Debt: a financial tool that affects most of us all yet is seldom talked about and mostly mis-understood. Movies love to show us the bad side of it (usually involving someone getting their legs broken) and Banks and Credit Card companies love to get us to sign up for it.
I typically meet two camps of people when it comes to debt: those that feel debt is wrong, negative and avoid it like the plague…and those that are shopaholics and use debt constantly and wind up in trouble for it.
Some debt can actually be good. Other debt is inherently bad. Let’s look at some examples:
Credit card debt – good debt (can you believe I said that) ONLY IF you pay off the entire balance every month on time. If you do not, then credit card debt is some of the worst debt out there (other than Russian mobster debt – see broken legs reference above).
Why is credit card debt, when used right, good? Because it’s like a 15-30 day interest free loan that actually helps boost your credit rating (more about that in a future post), can give you points for travel and stuff (I love free stuff!!) and keeps you from having to carry large amounts of cash around that isn’t very safe.
I personally like using a Credit Card better than a Debit Card and certainly better than using Cash…and again, that’s ONLY if you are paying off the FULL balance every month! If you are unable to do that, then DO NOT use this kind of debt as it can produce a mountain of bad debt!!
Lines of Credit – can be good or bad but most people utilize them for bad debt. A line of credit can be a great tool you use (basically just a loan from your Bank that is sitting there with all the terms set up for when you need it. Don’t use it, pay nothing. Start using it, start paying interest). If you have to get through a tricky financial situation, need a bridge loan (money that gets you through to a certain time when other money is coming in) or you use a Line of Credit to purchase an investment (borrowed money used for certain investments can be written off come tax time. Conditions apply), Lines of Credit can be good debt.
Used to pay for toys, home renos you can’t afford or if you just dip into them over and over because you can’t manage your finances properly (and are always paying interest on them month after month), they are slightly better than Credit Card debt (typically better interest terms) but still bad debt. Sometimes I do recommend clients utilize them to pay off Credit Card debt because you can usually get much better interest terms and therefore pay off the total debt sooner. It’s not great debt; it’s getting rid of horrible debt…;)
Mortgage debt – perhaps the most mis-understood form of debt out there and I’m going to do an entire blog post on this in future. Many people consider this a necessary evil and work to pay off their mortgage as fast as they can. I am not one of them (who taught you that was a good thing to do – your Bank? Have you ever known your Bank to really have your best interests at heart? News flash: Banks are in the business of making money for their Shareholders and Executives…not making money for you).
The reality is, without Mortgage debt, 95% of the population would never own a home and the stats show, owning a home and raising children in a stable home environment has multiple benefits. Because of this, as a whole, Mortgage debt is Good debt…but how you handle it and the terms to that debt can turn it from being true Good debt to being mediocre or Bad debt.
As I said, we’ll cover it in its own post so hold tight for now. Just know that I am NOT a proponent of always, at all costs, paying off your Mortgage debt as fast as you can…more about that in my future post.
Borrowing From a Friend – In most cases, this becomes Bad debt because it often ruins friendships. Why? Because the terms of the debt, repayment, interest are not properly defined up front (BEFORE the money is lent) and then fights ensue later on when the two parties don’t see the debt in the same way. Communication breaks down, phones stopped being answered and the Friendship ends or is at risk.
This can be Good debt (if your friend offers you better terms than your Bank) but you want to formalize a document outlining the terms of debt (just like your Bank would), establish collateral (what you are putting up to cover the debt should you not pay it back) and both sign the document. Google “Promissory Note” (that’s right, that thing from Monopoly you always wondered about) for a template. Ideally, you’d have a lawyer review it beforehand and advise you on how to execute it. If done this way, Friend loans can be a positive way to get through a tough time (who doesn’t want to help out a friend??!)
The Bank of Mom & Dad – See borrowing from a friend…same rules apply to keep family harmony.
Debit Cards – actually not debt…the money comes straight out of your account when you use them so it’s just a convenient replacement for cash. Good if you are unable to manage having a Credit Card (because you can’t spend what you don’t have).
Hopefully that gives you a snapshot of some of the easily available debt that is out there and whether it’s a good idea or not.
For more info or a more personal evaluation of your debt situation, drop me a line and put Debt or No Debt in the subject line.